Weekend Reading: Couch Potato Edition

Canadian Couch Potato godfather Dan Bortolotti recently posted the returns for his three model portfolios. Like my two-ETF portfolio, which returned 14.06 percent, Dan’s model portfolios had a banner year in 2017. Here are the results for the most aggressive versions of each portfolio:

Tangerine’s Balanced Growth Portfolio – 9.5 percent

TD’s e-Series Funds – 11.8 percent

Three-ETF Solution (ZAG, VCN, XAW) – 12.3 percent

These are excellent returns that reflect just how well the Canadian, U.S., and International equity markets performed in 2017. If you’ve recently looked at your portfolio’s performance and found the results lacking, you might be contemplating a switch to indexing.

Indeed, I’ve received many emails this week saying something to the effect of, “after reading about your 14 percent returns I’m convinced I need to make the switch to indexing.” This has me concerned for a few reasons.

Let me be clear: I don’t want you to change your investing strategy just to chase past performance. The beauty of indexing is that you take what the market gives you, minus a very small fee. My portfolio has benefitted from the incredible run that the stock markets have been on over the last few years. That could change at any moment.

We could see a correction this year, for example, and then I’d feel terrible that you jumped on the indexing bandwagon only to see your portfolio go down in value! As a passive investor, you have to be prepared to take some losses when markets are down and have faith that they will come back (as they always have) over the long term.

So, if you’re looking to get out of your actively managed portfolio, I’d much rather see you switch to indexing because of the lower fees (likely a fraction of what your mutual funds charge, right?). Say you have a $300,000 portfolio of bank-managed mutual funds. An average of 2% MER will cost you $6,000 every single year. Compare that to an indexed couch potato portfolio at 0.50% MER, which will only cost you $1,500 per year, and you’d save $4,500 in fees every year.

Over time those fees drag down your investment returns and can cost you well over $100,000 throughout your investing lifetime. Yikes! It’s fees, not past performance, that is the best predictor of future returns. The higher the fee, the lower the return (and vice-versa).

Finally, if you’re feeling any angst over becoming a DIY investor, I’d strongly encourage you to consider using a robo-advisor. You’ll get all the benefits of a indexed portfolio, plus the robo will take care of your asset allocation and rebalancing. Just contribute regularly and the robo will do the rest, in exchange for a small fee.

Don’t get me wrong, I’m thrilled that so many of you are considering a switch to indexing. Just make sure you’re doing it for the right reasons – to save on fees, not to chase past returns. Low fees = higher returns over the very long term, but over the short term your mileage may vary.

“There have only been three times in the last century when stocks almost exactly doubled in a decade. Returns were nearly identical during these three periods, down to the basis point. But the path and emotions that got you there couldn’t be more different:”

@Harold,
If your investments are in a non-registered and therefore taxable account, then sales of those securities will result in a capital gain or a capital loss. If you don’t have any losses to reduce your gains, then, yes, you will have a taxable gain. One option to limit your taxable gains is to make the switch over more than one year (spread over two, three or more years, depending on how big a tax hit there might be). But, if you’re switching from actively managed mutual funds with high MERs, or if the demand on your time to manage your accounts is excessive. or you just want to get it done and move on, then realizing the capital gain may be worth it to liquidate all at one time. Only you can decide that, perhaps in consultation with a fee-only financial planner (hint, hint, Robb and Marie).

If however, any of your investments are in registered plans (TFSA, RRSP, RRIF, RESP, RDSP), there are no tax consequences upon selling your current investments to buy index mutual funds or ETFs, as long as they remain inside a registered plan.

Thanks for sharing the different performance. What do you attribute the performance difference between the 3 portfolios and yours? It’s a big gap between the 9% and your 14%. Even for indexing, that’s a lot of money not earned with the tangerine portfolio.

The Tangerine Fund, in addition to charging more (1.07% MER) is only 75% equities, plus it only holds large-cap stocks in Canada, U.S., and International. TD e-Series has broader exposure in Canada, but only tracks large-cap stocks in the U.S. and International. The ETF portfolio holds hundreds of mid and small cap companies across the globe, in addition to being the only portfolio to track emerging markets (which performed really well). Of course, the ETF portfolio is also the cheapest one.

Why did mine outperform all of these portfolios? Well, my two-ETF portfolio is 100% equities – so that definitely played a role. And finally, the reported Couch Potato returns are time-weighted, whereas my returns are money-weighted and account for the contributions that I made throughout the year.

For many years interest rates have been low, benefitting bond markets. Now that interest rates are climbing, is it still prudent to keep 40% to 55% in bond etf’s for long term cautious or balanced portfolios? I currently hold the 3 etf portfolio with 45% in ZAG.

Hi John, great question. I think it is still prudent for most people to hold a balanced portfolio that includes some portion of bonds. We’ve been hearing about the great bond bubble and its decline for years, bit the decline hasn’t really materialized. ZAG was up 2.5% for the year, about what you’d expect from a bond fund (but still quite surprising considering the Bank of Canada hiked rates twice). Bonds are doing their job.

The better question for the crystal ball might be, “now that the stock market has been on a nine-year run, is it still prudent to keep a large percentage of your portfolio in equity ETFs?”

The answer to both questions is yes, you should likely continue to hold to your initial asset allocation. Perhaps when we see the next 20% decline in the stock market you’ll be glad your bonds are still intact to cushion the fall (and to help you rebalance by selling off some bonds to buy more stocks when they’re on sale).

I am happy to report my funds did a very respectable 13.92% (using Justin Bender’s spreadsheet). However, I have allowed myself to get into a few stocks and run 5 different ETF’s right now. All seemed a very good idea at the time but it clearly shows from the examples mentioned that more funds is not necessarily any better. There are so many different ETF funds available now but I have to force myself to get back to basics and keep it simple. Simple is better and is obviously performing just as well.

Hi John, very nice returns yourself. I hear you, simple is better. When the Couch Potato first came into prominence I didn’t like the portfolios that consisted of 5-10 ETFs (remember the Uber-Tuber?). It was when the All-World ex Canada ETFs came out that I was hooked and made the switch. I like having one product that captures 10,000+ small, medium, and large-cap stocks from around the globe.